Since the Global Crisis, international banks have reduced cross-border lending but continued to lend through their branches and affiliates overseas. This column argues that the observed shift was to a significant extent driven by regulatory changes. It should improve financial stability in host countries of foreign banks.

International banking since the Crisis

Three facts summarise the changes in international banking since the Global Crisis.

Cross-border bank lending – that is, direct lending to non-affiliated entities abroad – has fallen relatively to local lending through subsidiaries or branches of foreign banks – for example, a loan of a subsidiary of a foreign bank to a firm or a household in the same country (Figure 1). Cross-border claims were about one-third larger than local claims in 2007. In 2013, both were roughly equal.

Total foreign claims (the sum of cross-border claims and local claims of foreign banks’ affiliates) have declined and this decline is mostly due to Eurozone banks (Figure 2). Claims from other countries have recovered from their 2008 trough.

Figure 2. Foreign claims by home countries of banks (trillions of US dollars)

Banking regionalisation has increased, especially in Asia. The geographic breakdown of the assets of some 25 Asian banks shows a rise in the share of assets held regionally (Figure 3). Asian banks reporting to the BIS also hold a growing share of total banking claims on emerging market and developing Asian and Pacific countries, while the share of Eurozone banks has shrunk.

Figure 3. Geographic breakdowns of assets of Asian banks (per cent)

Sources: Datastream/Worldscope, and IMF staff calculations.

Effect of regulatory changes

Regression analyses suggest that regulatory changes have contributed to a sizeable extent to the decline in cross-border claims to GDP. The dependent variable is the growth rate of different types of banking claims from a given home country to a host country, between the pre-Crisis (2005–07) and post-Crisis (2011–13) periods. Explanatory variables include indices of changes in the regulations on banks’ international operations, indices of changes in capital requirements and supervisory power, an indicator of pre-Crisis health of the home country’s banking system, and several macroeconomic variables such as GDP growth and real interest rates in both home and host countries to capture changes in the demand for credit. Regulatory variables come from a confidential survey on the regulation of banks’ international operations conducted specifically for the IMF’s Global Financial Stability Report (IMF 2015), and from the Bank Regulation and Supervision Survey conducted by the World Bank. Roughly half of the observed decline can be traced to regulatory changes, particularly in home countries.

This conclusion is robust to including other control variables and excluding Eurozone countries from the sample or treating them as a single country. Instrumental variable estimation, in which the capital regulation and supervisory power indices in 2003 and 2006 are used as instruments for the indices of regulatory changes in home countries, further confirms the results.

Implications for financial stability

Cross-border lending is a particularly volatile form of capital flows – it is more sensitive to the VIX index than local claims of affiliates and portfolio investment flows. Everything else equal, the shift from cross-border banking to more local banking can thus be expected to reduce the sensitivity of total capital inflows to global financial shocks.

Countries that receive more cross-border loans are not only more exposed to global shocks – they do not seem to enjoy a diversification benefit when hit by domestic shocks, either. Domestic credit falls more around domestic shocks in countries receiving larger cross-border claims. This finding can be related to other work pointing to the financial stability risks associated with bank wholesale funding (Berkmen et al. 2012). Claims vis-à-vis non-affiliated banks represented around 28% of total foreign claims in the pre-Crisis period; they dropped by a third between 2007 and 2013.

In contrast, local lending by foreign subsidiaries can play a stabilising role during domestic crises. This finding is consistent with the literature reporting that lending by subsidiaries is more stable than direct cross-border lending (Peek and Rosengren 2000, De Haas and van Lelyveld 2006). Foreign subsidiaries with better capitalised parent banks and parent banks with more stable funding sources tend to react less procyclically during both domestic and global crises.

Policy recommendations

These results speak in favour of a multinational banking model in which global banks operate through affiliates in different countries rather than in a cross-border fashion (McCauley et al. 2012). Regulatory reforms aiming at reinforcing the capital and liquidity buffers of global banks can also help to enhance the stabilising role of foreign subsidiaries on credit supply during crises.

However, no banking model seems to reduce the negative effects from global shocks. A close monitoring of cross-border and foreign currency lending, more cooperation among national supervisors, and progress on cross-border resolution are therefore needed to limit the financial stability risks associated with those shocks.

Disclaimer: The views expressed herein are those of the authors and should not be attributed to the IMF, its Executive Board, or its management.